Today, Ajay Mehrotra, Northwestern University and the American Bar Foundation, will present "The VAT Laggard: A Comparative History of U.S. Resistance to the Value-Added Tax, as part of the annual Spiegel Sohmer Tax Policy Colloquium at McGill Law. This is a fascinating topic as the United States considers major tax reform without explicitly embracing VAT as much of the rest of the world has done. Prof. Mehrotra's new project will explore the U.S. position in light of how Canada, Japan, and other jurisdictions were able to overcome historical resistance to a national VAT by adopting a Goods and Services Tax (GST).

The tax policy colloquium at McGill is supported by a grant made by the law firm Spiegel Sohmer, Inc., for the purpose of fostering an academic community in which learning and scholarship may flourish.

The land on which we gather is the traditional territory of the Kanien’keha:ka (Mohawk), a place which has long served as a site of meeting and exchange amongst nations.

This fall, in celebration of the centennial anniversary of the introduction of federal income taxation in Canada, the Colloquium focuses on the historical significance and development, as well as the most recent challenges, of the modern tax system in Canada and around the world. The complete colloquium schedule is here.

Share:

In an interesting twist on contemporary debates about tax planning by multinational companies, Prof. Leandra Lederman recently posted a very interesting column about how one government seems to have benefited from some clever tax planning at the expense of its own national government, with the help of a multinational company that appears to have received nothing for its trouble.

This is the strange case of Volkswagen's tax structuring involving the Spanish provinces of Navarre and Catalonia. What is strange is that, in this particular instance, Volkswagen's structure appears to have created no tax benefit for itself, but resulted in the province of Navarre effectively transferring itself a large pot of revenue from the national coffers.

Prof. Lederman's post explains that Navarre is an "autonomous community", which, unlike Catalonia, independently administers the VAT, and therefore only issues VAT refunds when products are exported from Navarre to a buyer located outside of Spain. (Most of Spain's other provinces have a harmonized VAT system administered at the national level). If products are sold to a buyer outside of Navarre but still in Spain, such as Catalonia, Navarre does not issue a refund because there has been no export. But if the purchasing company in that other province then sells to a subsequent buyer outside of Spain, the Spanish Treasury issues a refund to the company and voilà, Navarre has transferred itself a windfall in the amount of tax it collected and Spain paid back.

Over a period of several years, Navarre reportedly collected approximately 1.5 billion Euros from the Spanish government using Volkswagen in this manner. By routing its export sales through an intermediary in Catalonia rather than directly from Navarre, Volkswagen acted as a conduit to route revenues from the state to the province. Given its own indifference to who, as between Navarre and Spain, refunds the VAT on its exports, using an intermediary in Catalonia appears like an act of pure generosity to the province of Navarre. Prof. Lederman goes through the case that brought this issue to attention and queries: what's in it for Volkswagen? She notes that nothing in the public record suggests that VW received anything in return—"it simply did Navarre a favor." That seems unlikely; certainly, as Lederman points out, Navarre would be capable of having made some other concessions. These would not necessarily be made public.

Absent concessions, is this a modern day Robin Hood story, with VW effectively taking from the state to give to the province? Navarre is not quite at the bottom of Spain's provinces economically (at least according to wikipedia) but neither is it near the top spot in terms of gross regional product (it is, however, near the top in terms of purchasing power parity, as well as in other factors such as employment rates). Should we cheer or disparage the tax trickery that resulted in an ongoing transfer of wealth from Spain to Navarre?

Also curious is why Spain wouldn't have anticipated this problem far in advance of this situation arising. It seems that the government proposes to resolve the issue by renegotiating the Convenio Económico Navarra-Estado (Navarra-State Economic Agreement), which governs the VAT administration among other matters. I am no VAT expert but it seems to me that having designed a destination based VAT system and having agreed to independent administration of that system by one or more of its provinces, the state might have immediately recognized that revenue transfers from itself to the non-harmonized province(s) would be likely unless there was some mechanism requiring the VAT-collecting province to be the VAT-refunding province in the case of ultimate exports.

Like Prof. Lederman, I would be curious to know whether this sort of situation has arisen in other contexts--do sub-national governments routinely look for ways to transfer state revenues to themselves using taxpayers as conduits? Should we liken the province's passively benefiting from a system not solely of its own making as acceptable tax planning or harmful tax competition? Likewise, should we view the taxpayer's willingness to facilitate the transfer (for apparently no reason but its good nature and general willingness to cooperate) as a victory or a failing in the taxpayer-state relationship?

Share:

I've been fielding several "what is is this DBCFT idea" kinds of questions so I thought it might be helpful to present the six basic features of the DBCFT as proposed (in very general form) by Paul Ryan and a very simple chart to explain how the DBCFT would "work" if it was enacted as described in Ryan's "Better Way" plan.*

Accordingly, based on that proposal, the six main features of the DBCFT would be:

domestic sales are included

foreign sales are excluded

dividends from foreign subsidiaries are exempt

all foreign costs are non-deductible

net interest is non-deductible

allowable domestic costs are immediately deductible (expensed)

Obviously these are oversimplifications and I'm ignoring transition rules and so on, but these are the basic building blocks. The Ryan plan proposes a tax rate of 20%.

So what happens if these building blocks are put in place via legislation, assuming away all transition issues etc., and that a tax imposed is a tax collected?** If we imagine a product that will sell for $125, and costs $100 to produce (in materials and labour), this is what happens:

Box 1: MAGA ideal: made in America, by Americans, for Americans. Tax will be collected on profits earned by selling goods produced & sold domestically. The DBCFT most resembles an income tax in this scenario (though expensing and non-deductibility of interest still moves it toward a consumption base); it will also be the easiest to collect.

Box 2:Exports. Tax exemption for sales abroad will create (possibly permanent) NOLs to carry forward indefinitely. This will require deciding on loss-shifting policy. This is obviously not an income tax but it not a VAT either.

Box 3:Imports. Sales in the US of goods produced abroad are taxed on a gross basis, more like an excise tax (or yes, a tariff). With an estimated $1.2 trillion trade deficit, this part of the DBCFT is expected to raise the most revenue but the success of that strategy depends to some degree (maybe a large degree) on remote sellers collecting tax (that’s complicated--see Europe).

Box 4:Foreign Sales of Foreign Products. Neither costs nor revenues are counted for goods produced and sold abroad, even if produced and sold by a US-based company. This part of the DBCFT would be more or less consistent with either a VAT or territorial income tax.

That, in a nutshell, is the basic skeleton of the DBCFT as proposed in the Ryan plan. It will be interesting to see what, if any, of this ends up enacted IRL.

* There is absolutely zero chance that the proposal will be enacted as described. Still, it is helpful to understand the basic vision. I do not claim to be an expert on the DBCFT and offer here no analysis or predictions about the incidence of the tax, or the impact such a tax would have on US or world capital flows, investment, consumption, economic growth, or international relations. This paper by Wei Cui, orthis one by Wolfgang Schoen are helpful in addressing many of these issues.

** A tax imposed is never a tax collected. There is always a gap between a great idea (or for that matter a not so great idea) and something that can actually be carried out: tax administration is tax policy.

Share:

In September, Donald Trump started calling for the US to tax imports from Mexico and China etc, on various theories having to do with his vision of what fair trade policy involving the United States would require. Democratic lawmaker Bill Pascrell appears to have seized the moment to re-introduce a bill that has failed multiple times in the U.S. Congress over the years, namely, the so-called Border Tax Equity Act. The idea of this act is simple: tax US consumers on imports and give the money to US companies that export things. If you find it amazing that anyone anywhere could support a tax and redistribute scheme like this, blame it on the pitch: Pascrell (and others) laud this as an answer to what they have characterized as a discriminatory practice, namely the exemption of exported products from value added taxes (VAT) by the 160+ countries that have federal consumption taxes. The argument is that "[t]he disparate treatment of border taxes is arbitrary, inequitable, causes economic distortions based only on the type of tax system used by a country, and is a primary obstacle to more balanced trade relations between the United States and its major trading partners."

This argument is specious and I don't expect the bill to pass but this issue is one that just does not seem like it will go away, I think because it is too easy to pitch the VAT border tax adjustment as "unfair." I had an exchange with trade expert Simon Lester almost ten years ago on this very subject, and re-reading my response today, it seems to cover the bases so I thought I would re-post it. You can see his original post here including a discussion in the comments between myself, Simon, and Sungjoon Cho on the matter. Sungjoon helpfully linked to a GATT working party report from 1970 but his original link is dead, however you can find that report here. Here is what I said (highlights added):

The great fallacy here is that the foreign exporter to the U.S. is somehow subject to no tax while the U.S. exporter is subject to two taxes. This is simply not the case. Other countries, especially our biggest trading partners (e.g. Canada) have both a federal corporate income tax and a federal consumption tax, while the U.S. has only a federal corporate tax. You cannot honestly assess the impact of the VAT in the context of only one country’s corporate income tax, and supporting this legislation this way is dishonest. The Textileworld site you reference conveniently ignores foreign corporate taxes in its analysis—I will leave you to decide for yourself why they might do that.

...I will give a drastically oversimplified example. Assume a U.S. person manufactures a product in the U.S. which it will sell in Canada. The company’s profit on the sale is subject to federal income tax in the U.S., plus VAT in Canada (there called a general sales tax). Let us assume a Canadian company makes a similar product. With the same profit margin as the U.S. company on that product, the big issue here is the different rates of federal corporate taxes each company pays to its home country, because both pay an equal amount of VAT tax in that market. What the export credit in the U.S. would do is lower the U.S . company’s federal income tax burden relative to the Canadian one.

Now flip the scenario, the U.S. manufactures and sells a product in the U.S., where there is no VAT, and the Canadian company manufactures a product in Canada to sell in the U.S. Now each company again will pay its income tax to its home country but what happens to the VAT? Well there is no U.S. federal sales tax, and Canada’s VAT only applies to sales in that market, so the VAT is not imposed on the Canadian product coming in to the U.S.—it is exempt from their VAT. Again, in the U.S. market, there is no price distortion other than the difference in corporate income tax burdens—neither product is subject to VAT. If the U.S. imposes a border tax, I think you might now see that as distortionary (to the extent you believe that a tariff is distortionary in any event). Now you might say yeah, but many states have state sales taxes, wouldn't that equalize the incoming product, exempted from sales (VAT) tax in its foreign country? The answer is, of course, yes. But you don’t see very many people complaining if New York does not impose its sales tax on a product being shipped out of New York for sale in Canada—that is a (much-ignored) direct corollary to the VAT exemption.

I could go on but this argument has been made many times before. I appreciate that tax is complex and there are many alternative taxes and scenarios in which they apply differently, so that it is easy to be swayed by something that “seem unfair.” The bottom line is that people will continue to compare VAT to income taxes when it suits their purposes (i.e., supports protectionist policies like the border tax), and not when it doesn’t (i.e, when they want to pressure a government to lower its corporate tax rate to align with other nations’ corporate tax rate). But don’t be fooled by someone who tries to get you to look at one piece of a complex puzzle and guess what the image is.

Further...

[I]f you seek a level playing field, border taxes and rebates do not achieve that, and in fact, I doubt anyone could ever be confident about how to go about getting it via tax breaks for some and tax penalties for others (I have some ideas about where I would start, but I'll restrain myself). A border tax/rebate does not operate like an inverse VAT or offset an extra cost imposed by a VAT. A border tax is a tariff and a rebate is a subsidy, plain and simple, and I would expect many of our trading partners to oppose it if enacted.

Incidentally, abolishing all income taxes might solve the problem of the income tax competition, but then you have a much different problem. By some estimates, if the U.S. were to abolish the income tax entirely in favor of a sales tax, the rate could be as high as 50%. More likely scenario: we keep the income tax just like it is and ADD a 10-20% federal VAT. This would get rid of the erroneous "VAT as distortion" complaint but I personally would rather keep the debate and take a pass on the VAT.

Economists have long recognized that border tax adjustments have no effect on a nation's competitiveness. Border tax adjustments have been shown to mitigate the double taxation of cross-border transactions and to provide a level playing field for domestic and foreign goods and services. Hence, in the absence of changes to the underlying macroeconomic variables affecting capital flows (for example, interest rates), any changes in the product prices of traded goods and services brought about by border tax adjustments would be immediately offset by exchange-rate adjustments. This is not to say, however, that a nation's tax structure cannot influence patterns of trade or the composition of trade.

In summary: No, taxing at the border for the reasons given does not introduce "equity." It introduces WTO-prohibited tariffs and export subsidies. One could imagine that if the tariffs so raised were used to fund public goods, the possibility for an equitable outcome could be increased. But taking the money out of the pockets of US consumers and putting it in the pocket of US exporters in no way fulfills the stated policy goal.

Share:

Further to my last post on the newly released Tax Gap study by the Canada Revenue Agency, the following comes from guest blogger Iain Campbell (ARC, UK):

I hope this
comment is not too long but I’ve been following Tax Gap discussions for so long
that it’s hard to pass by the chance to comment!

Background

This is an
interesting development. Writing from the UK I’m not in regular contact with
developments in Canadian tax administration. But I do recall there has been
some entertainment over the Tax Gap, with the Parliamentary Budget Officer asking
for the CRA to do some work on it - and being rebuffed.

In fact, the CRA
has not been keen on preparing a Tax Gap analysis. In 2002 it reported that attempting
to estimate overall levels of reporting non-compliance such as the ‘tax gap’ or
the total amount of smuggling activity was fraught with difficulty. (CRCA
Performance report
for the period ending 31 March 2002.) Ten years later the CRA were still not
convinced. At the start of 2013 they told the PBO:

The CRA later pointed
out “the significant debate about the precision, accuracy and utility of any
methodology to calculate the tax gap”. It drew attention to critical comments
from the UK Treasury Select Committee, as well as the fact of 52 tax
administrations surveyed by the IRS, 33 did not produce one, and the high costs of doing so. (CRA, PBO
Information Request
IR0102: tax gap estimates, letter 20 March 2013,] and PBO Information Request
IR0102: tax gap estimates, letter 1 August 2013.) In 2014 the PBO even
threatened to take legal
action in order to compel production.

But in the
recent election there was a promise to undertake such a study, ending this long
standing reluctance to follow the example of other countries, including the
USA and UK. And following the Panama
Papers the Revenue Minister said in January a tax gap study would be done.
The new Canadian study comprises a 31pp paper on a conceptual study of the
Canadian tax gap and an 11pp study on the Canadian GST/HST, which gives a gap
of 5.5% in 2000 and 6.5% in 2014. (It explicitly references the decision
announced by the Minister of National on 11 April.)

Basis of study – what’s in and what’s out

The conceptual
study does, to an outsider, seem to spend a lot of time in not saying a great
deal. It seems to add qualification to qualification, caveat after caveat, so
that at times I wondered if the CRA really wanted to publish anything at all. Gus
O’Donnell is the UK civil servant who wrote the Report that led to the UK Customs
and Excise combining with the Inland Revenue to form HM Revenue and Customs. In
that Report he surely got it down to a few words: “Making estimates of the tax
gap is methodologically and empirically difficult, although easier for indirect
taxes where tax can typically be related to consumption. Direct tax gaps are
particularly difficult to estimate because the aggregate figures for income,
for example, are built on tax data.”

The CRA's conceptual
study refers a lot to the HMRC papers and policies on calculating the Tax Gap.
But in some of the key areas it dances around what might be difficult decisions
e.g., whether to report the gross tax gap, or, as in the UK, the gap after
action to tackle non-compliance.

Avoidance

More
controversially, the UK includes tax avoidance. This is a good illustration of its overall
approach.

On the other
hand, academics and members of the accountancy profession have argued the
opposite, that any estimate should not include avoidance as referenced by the
“spirit of the law”. For example, during a Treasury Select Committee Hearing on
TheAdministration
and Effectiveness of HMRC, Judith
Freedman (Professor of Tax Law, Oxford University) commented “I really take
issue with the spirit of the law part, because either you have law or you don’t
have law and the law has to state what it is.”

The Canadian
paper discusses this option and concludes “the appropriate treatment of tax
avoidance is less clear”. It seems Canada has decided to not include avoidance
in its definition: “In general the CRA’s approach to the tax gap encompasses
non-compliance related to non-filing, non-registration (in the case of
GST/HST), errors, under-payment, non-payment, and unlawful tax evasion” (p29).There seems to be no explicit position on
avoidance but, although I doubt it will happen, “under-payment” is potentially
broad enough to include under-payment via avoidance.

Other “Gaps”

Another area the
study did not address is what the IMF and EU call the “tax policy gap”. I agree
with this decision (which mirrors the UK). The IMF would widen the definition
and use of the Tax Gap approach. It suggests including the effects of policy
choices that lead to reduced revenues. In a study
on the UK Tax Gap it refers to the impact of compliance issues on revenue as
“the compliance gap” and the revenue loss attributable to provisions in tax
laws that allow an exemption, a special credit, a preferential rate of tax, or
a deferral of tax liability, as the “policy gap” (para 68). As part of this they recommend tax avoidance
schemes deemed legal through litigation should be considered part of the policy
gap, not the compliance gap, and this distinction should be made clear.

A similar point
was made by an EU report
on VAT. They suggested that a possible link between
the policy and the compliance gaps, since using the reliefs and allowances
intended by policy could make compliance more difficult. “Reducing the policy
gap may often be the simplest and most effective way to reduce the compliance
gap. “ (p21)

In my view these
kinds of proposals are likely to be very complex, perhaps contentious, and hard
to administer. It seems a sensible decision to not refer to them or suggest
their inclusion.

Then there are
the base erosion issues where tax is avoided through the use of legal
structures that make use of mismatches between domestic and international tax,
e.g. permanent establishments. The Canadian study nods in the direction of BEPS
and then passes by.

What’s the point of working out a Tax Gap?

But putting
aside these sorts of issues, or whether “top-down” targeting is better than “bottom-up”,
does the size of the hidden or “informal” economy predict the level of GST/VAT
underpayment (or is it the other way around?), perhaps thebig $64K question is whether any of this
means anything. If there is no clear agreement on the numbers, how they are
calculated and their reliability, then is there are any point in preparing
them?

The very concept
of the tax gap is not universally agreed to be a useful analytical or strategic
lever. Apart from the earlier Canadian reluctance, the Australians were slow to
go down this road. UK Parliamentarians have been less than keen. In 2012 the
Treasury Select Committee said they thought it was essentially a waste of time
and resources. Worse, they feared it would misdirect HMRC away from ensuring
every taxpayer paid the right amount of tax. Such fears have not died. The
current TSC is examining UK corporation tax. Their early work involved scoping
the problem and they heard some evidence on the tax gap. Andrew Tyrie (the
Chair) seemed less than enthused at the very concept.

I think it has
merits. But it ought not to be elevated to some shibboleth. It is one high-level
measure of how successfully legislation is being applied, use of resources, etc.
The UK Government’s official
position is that that “thinking about the tax gap forces the department to
focus attention on the need to understand how non-compliance occurs and how the
causes can be addressed—whether through tailored assistance, simpler
legislation, redesigned processes or targeted interventions. Measuring the tax
gap helps us to understand whether increasing returns from compliance activity
reflect improved effectiveness or merely a decrease in voluntary compliance.”

The Canadian
paper says broadly the same things (pp22-24). It talks of providing insight
into the overall health of the tax system, of understanding the composition and
scale of non-compliance, but warns of their limitations.

If that is how
it used then I think it is a useful aid to policy making and how robust is the
assurance being provided by the tax administration.

Share:

The Government of Canada has released its first study of the "tax gap," which the Government defines as "the difference between the tax that would be paid if all obligations were fully met in all instances, and the tax actually paid and collected." The Canada Revenue Agency (CRA) has not completed a study of the income tax, but has released this paper on the concept and methodology. It has presented a report for GST/HST (Canada's VAT), estimating the tax gap to average about 5.6% per year over the period 2000-2014. For 2014, this produced an estimated tax gap of about $4.9 billion:

This study has been undertaken after many calls from academics and nongovernment organizations, including Canadians for Tax Fairness, which according to the CRA will be involved in consultations regarding the ongoing study. Canadians for Tax Fairness estimate that Canada loses $7.8 billion in income tax revenues to "tax haven" use, a number they constructed using Statistics Canada's foreign direct investment data.

The Government acknowledges that there is no reliable method for measuring the tax gap, and that the exercise is one in speculation based on imperfect information:

There are a number of challenges facing tax administrations undertaking tax gap estimation. The key challenge is access to the comprehensive and good-quality data necessary to produce estimates. A significant proportion of the tax gap involves unreported or under-reported income and assets and economic activity that are deliberately hidden from the government. As a result, many countries that publish tax gap estimates highlight their uncertainty.

Expect more to come from this exercise as the tax gap study is a key component of the Government's pledge to spend $444 million over five years "to enhance [CRA] efforts to crack down on tax evasion and combat tax avoidance."

Share:

Michael Graetz has been working away at convincing Americans to accept a national level consumption tax, and he has another go at it with The Tax Reform Road Not Taken -- Yet. Here is the abstract:

The United States has traveled a unique tax policy path, avoiding value added taxes (VATs), which have now been adopted by every OECD country and 160 countries worldwide. Moreover, many U.S. consumption tax advocates have insisted on direct personalized taxes that are unlike taxes used anywhere in the world. This article details a tax reform plan that uses revenues from a VAT to substantially reduce and reform our nation’s tax system. The plan would (1) enact a destination-based VAT; (2) use the revenue produced by this VAT to finance an income tax exemption of $100,000 of family income and to lower income tax rates on income above that amount; (3) lower the corporate income tax rate to 15 percent; and (4) protect low and-moderate-income workers from a tax increase through payroll tax credits and expanded refundable child tax credits. This revenue and distributionally neutral plan would stimulate economic growth, free more than 150 million Americans from having to file income tax returns, solve the difficult problems of international income taxation, and remove the temptation for Congress to use tax benefits as if they are solutions to the nation’s pressing social and economic problems.

Prof Graetz has been working on this idea for quite some time and he's likely right that a national consumption tax would solve some major problems for the US income tax system. It would reverse the "income" tax from a mass tax to a class tax again, refocusing the income tax regime on its most productive base, namely, the upper-middle class. It would go a long way (but not by any means all the way) in resolving some of the worst aspects of citizenship taxation. It is just a fact that including non-residents as if they were resident throws people right into the deep end of US tax law even if they are regular working class households, because everything they do is "foreign" and therefore subject to the world's most complicated anti-avoidance regime. Eliminating income taxation for a large majority of those people would go some steps toward a remedy without actually fixing the fundamental problem.

But Prof Graetz's has been an uphill battle. I can think of at least two main reasons for this: first, introducing any new tax is political suicide in the US and second, it would be little more than a double tax (for those that would remain in the income tax system) because the US income tax is in large part already a consumption tax in that it exempts so much in the way of savings. As we know from Haig-Simons, income equals consumption plus delta savings over the period. When savings are exempt, income taxation is equivalent to consumption taxation. So introducing VAT in the US means imposing a new consumption tax on the very same base as something we currently call an "income" tax.

For those that would be exempt from the income tax, the VAT would simply step in and claim roughly the same amount of tax, and therefore presumably the picture wouldn't change much in terms of revenue raised, but would change quite a lot in terms of form filling and paper filing, which means less administration for the same tax. That would be great for the ever-starving IRS. (A cynic might observe that it could mean less from penalties from those who fail to file things properly, which is set to become a most fruitful source of extra revenue in just a couple of weeks.)

Moreover, the switch from an income tax system that ultimately acts like a consumption tax to a straightforward an easier-to-administer consumption tax might solve the revenue problem, but it would still need cash transfers to solve the progressivity problem and therefore can only be solved with another form of political suicide, namely, increasing welfare payments to the poor (that's the "refundable credits" part of the plan).

Still, worth reading and watching as Prof Graetz continues to wage what often seems like a one-man battle to change attitudes toward a national VAT in the United States. It is striking how difficult it is to convince Americans to embrace a tax that would do almost exactly what the current income tax system does, but at a fraction of the cost. On principle people really still like the income tax and they really hate the idea of a national consumption tax. Cognitive dissonance? Or a naïve hope that the income tax can be restored to its former glory if we can only figure out a way to tax savings again?

Share:

Today is the first day of the Tax Justice and Human Rights Research Collaboration Symposium, a three-day conversation among students, academic researchers, and tax justice advocates and activists on the topic of tax justice: what is it, how is tax connected to human rights or how could it be, and what research needs to be done to further this emerging field? You can follow the proceedings and make comments on twitter at #TJHR.

Featuring Alex Himelfarb (Director, School of Public and International Affairs, York University); Kate Donald (Adviser to the United Nations Special Rapporteur on Extreme Poverty and Human Rights); Attiya Waris (Senior Lecturer, Faculty of Law, University of Nairobi); and Denise Byrnes(Executive Director, Oxfam Québec)

Share:

The Victoria University of Wellington (Australia) has a new SSRN issue of interest, featuring a series of papers by Sybrand van Schalkwyk and the ever-prolific John Prebble, all on the topic of consumption tax and financial services. The first of these is the big picture:

Value added tax (VAT) is a relatively modern development. Designers of VAT recognized from the outset that the way in which financial institutions are remunerated creates significant difficulty when the tax is applied to their services. Administrative difficulties relate to imposing invoice-based VAT on service fees charged as part of the margin between buy and sell rates. Theoretical reasons relate to arguments that financial services should not be taxed under a consumption tax because, it is argued, financial services are not consumed in the way in which goods and services are consumed. Because of these difficulties, most jurisdictions have opted to exempt financial services from VAT. However, the commonly accepted reasons to exempt financial services from VAT are not compelling, since financial services are no different in relevant respects from other services. Moreover, there are methods by which financial services could be brought within the VAT base. Furthermore, although exemption is the simplest way for a VAT to treat financial services, it causes significant distortions in the economy.

This paper is of special interest to me because it confirms my own view that societies are increasingly accepting tax systems that intentionally tax the "easy-to-tax" most vigorously, the "hard-to-tax" much less vigorously and more randomly, and the "impossible-to-tax" not at all, and that these categories have been intentionally constructed from regulatory decision-making that renders various activities to a given category in systematic and purposeful ways.

There are fundamental justice issues at stake in these regulatory outcomes. If Prebble and van Schalkwyk are correct that exempting financial services from VAT is a policy choice that has been made on the basis of an unexamined theory that these flows are hard or impossible to tax which in turn has been decided because of a failure to institute measures that would make them easy (or at minimum easier) to tax, then the failure to include financial services within existing VAT systems is a grave source of injustice within that tax policy choice (that is, in addition to and apart from the question about whether consumption taxation is itself a violation of justice in the exercise of taxation by states).

The papers that follow focus on various ways to increase the coherency of the taxation of financial flows--what I would suggest is an effort to show us that financial flows could in fact be easier to tax, if not "easy-to-tax," given various regulatory reforms:

This is the second of a series of four articles on the taxation of financial services under a value added tax. The first article considered whether, from a theoretical viewpoint, financial services should be included under a value added tax. It concluded that the arguments in favour of treating financial services in the same manner as any other service outweighed the arguments against doing so.

This second article considers the definition of interest bearing financial instruments in some detail. It also considers the kinds of activities that qualify as financial services in relation to the instruments. The definition of financial services is important where a different type of treatment is applied to financial services. If financial services were taxed like any other service, then no definition would be needed. However, where, as in New Zealand, supplies of financial services can be exempted, the definition of financial services becomes very important. Alternatively, if some financial services are to be zero rated or taxed but not others, then it is necessary to have a global definition of financial services followed by individual definitions of the particular kinds of service that are to be brought within the tax base one way or the other. This article begins by considering interest-bearing instruments.

Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, for instance tax cascading, which in turn causes price distortions. The application of VAT to interest-bearing financial instruments and life insurance is complicated by the way in which financial intermediaries charge for these services.

The first part of this article investigates how interest-bearing instruments can be taxed under VAT, and the second part how life insurance can be taxed under VAT. There are several options for the treatment of interest-bearing instruments. They can be exempted, zero-rated, or included in the tax base. In this last category, there are three possible methods of including interest-bearing instruments: the invoice, cash flow, and truncated tax flow systems. The last is recommended because policy makers have come to realize that the cash flow system cannot be applied without significant modification.

Exemption of financial services from Value Added Tax (VAT) is commonly accepted as being an anomaly in the New Zealand goods and services tax legislation. While exempting financial services from VAT is attractive to the legislature because it is a simple way of addressing the difficulties of applying VAT to financial services, it causes significant distortions, such as tax cascading, which in turn causes price distortions. The application of VAT to services that bring about the exchange of currency is one instance where financial services could be included in the VAT base. Services bringing about the exchange of currency are a species of financial service, but are inherently different from other financial services since they are relatively simpler than other financial services. Reasons advanced for exempting financial services in general do not necessarily apply to services bringing about the exchange of currency.

Bravo to the authors--this represents a lot of work and adds much to the discussion of how economically-integrated yet politically independent nations can approach the subject of taxation from the perspective that justice matters in policy decisions.

Share:

Everything, I am guessing. Tina will give up her US citizenship now that she has attained Swiss citizenship. Reason given: to "clarify her situation." John Nolte says "She's 73 years-old, her longtime partner lives overseas, and as far as I know she's not in any way making a political statement." He seems a bit puzzled about her decision to give up her status, and he welcomes her back anytime.

Well said. So why is she giving up her citizenship? Short of making a political statement, I can think of only one good reason: America's newfound vigor for enforcing citizenship-based taxation, and all of the surveillance and form-filling that entails. Just consider that giving up citizenship is not a simple matter of mailing in your passport. It can be a complex and time- and resource-consuming process which involves enhanced scrutiny and fees for those with high net worth, who are viewed as attempting to flee the tax jurisdiction.

The US has always had citizenship based taxation on the books, but it wasn't truly enforced until FBAR came under IRS authority and FATCA emerged as its enforcement mechanism in 2010. Now those who have not been compliant will be "rooted out" (former IRS Commissioner Shulman's description of FATCA) with ongoing monitoring, and hefty fines for failure to file. Those who have been compliant will go on to face a regime that is increasingly byzantine, with new forms and requirement seemingly being piled on all the time, in a situation that is becoming very lucrative for tax return preparers and the compliance industry in general--just google FATCA compliance officer job posting and you will get the idea. Of course, the regime is meant to catch Americans hiding their cash offshore: a laudable goal especially in light of so many high profile cases, many prominently featuring Switzerland.

So the question is whether Tina Turner is an "American" and if she, with her Swiss bank accounts, is "hiding offshore." This raises a series of unanswered questions about the relationship between the individual and the state, none of which, I think, are easily answered. These include, to which country does Tina belong, if she has dual citizenship? Is this a first come, first served world, so she belongs to the US in perpetuity, based on her birth in Tennessee, no matter where she lives out her life? Can she choose to belong to another country, or only if she is willing to pay the cost of her continued US status in the form of ongoing compliance with US tax law? Is Tina going to be allowed to leave the US jurisdiction only on the condition that she renounces any right to come back? What financial restrictions should a state place on people--especially wealthy ones--who want to move to other jurisdictions?

As long as Tina holds on to her citizenship, even if she is a dual citizen living in another country, the answer to the first question is that she is now and will ever be American. And as long as she has any accounts anywhere in the world outside of the US, the answer to the second is "guilty unless proven innocent on an annual basis." None of the other questions are answerable in law: all are a matter of opinion and, more than anything else, geo-political power.

I am sure that Tina's expatriation will be viewed by many as a response to the high US tax rate, or a betrayal of her US roots, or both. But it is likely neither. As a Swiss citizen resident in Switzerland, Tina's worldwide income is subject to income tax (federal, cantonal, and municipal), wealth taxes, VAT, etc., and we can only speculate about how much tax she may be asked to pay in the US after credits, exemptions etc. as a US citizen living abroad. It could very well be zero or close to zero. So it is seems more likely this is about the hassle of filing a thicket of tax forms, year after year, despite owing little or no tax to the US, and stiff penalties for even "non-willful" infractions, including mistakes. And it could be about having to do all of that because Americans living abroad are viewed as likely criminals because they have offshore bank accounts.

If Tina has been tax compliant all these years, she may just be exhausted with the effort; if not, she may see many reasons to cut ties by going the drastic step of irrevocable renouncement.

I would very much like to know if there is some other reason to give up her US citizenship. "Clarifying" one's situation seems just abstract enough to cover the hassle of dealing with US tax compliance.